Ukraine proposes lower iron ore royalty hikes

Ukraine’s parliament might set the highest mineral
resource royalty rate at 10% for iron ore mining companies, according to a June
2 law draft.

 

The 10% rate will apply if a CFR China index for fines
with 62% iron content averages above USD 200/t for the payment month. If the
index is between USD 100/t and USD 200/t, a 5% rate will apply. For index
monthly averages below USD 100/t, a 3.5% rate is proposed.

 

The June law draft also introduces an adjustment
coefficient of 0.9x for iron ore mining rent payments.

 

Recall, in April media reported Ukrainian government’s intentions to set the
highest royalty rate at 16% if the CFR China index is above USD 180/t.

 

In March, media reported plans to set the rate at 5% flat.

 

The royalty payment base in the June law draft will
change to the value of the 62% CFR China index itself, the same as what was
reported in April and March. Presently, the base is essentially the cost of
iron ore mined before enrichment and pelletizing, and amounts to USD 20-30 per
ton of the final goods. The current rate is 12% for a price index for 58% iron
fines CFR China above USD 70/t and 11% otherwise.

 

Dmytro Khoroshun: The current
proposal should not impact creditworthiness of either Metinvest (METINV) or
Ferrexpo (FXPO LN).

 

The June version will lead to more moderate changes in
royalty payments than the April version: the hikes will be smaller for periods
of high prices, and the decreases will be smaller for periods of lower prices.

 

The changes will increase royalty payments by up to 3x
when prices are elevated, and by 6x and more for periods of exceptionally high
prices. During periods of prices around and below the expected long-term
average, royalty payments will be lower than what the Ukrainian producers of
concentrate and pellets pay under the current royalty regime.

 

Namely, when the 62% iron index is close to but below
USD 200/t (5% rate applies), the royalty would increase by up to 3.0x, to USD
9/t or less. Metinvest’s annual royalty payments (including 46% of royalties
paid by its Southern Iron Ore joint venture) will increase by up to USD 213 mln
(10% of 2020 EBITDA) to up to USD 320 mln (15% of 2020 EBITDA), we estimate.
Ferrexpo’s annual payments might increase by up to USD 71 mln (8% of 2020
EBITDA) to up to USD 107 mln (13% of 2020 EBITDA).

 

However, when the prices exceed USD 200/t (10% rate
applies), the royalty payment would increase by at least 6.0x to USD 18/t or
more. Still, this is substantially below USD 32/t or more under the April
proposal.

 

On the other hand, for a reasonable long-term average
of USD 75/t for the 62% CFR China index (3.5% rate applies) the royalty payment
would drop about 20% to USD 2.4/t, assuming the 0.9x adjustment coefficient
will apply during such periods. The April proposal was for the rate at a
slightly lower 3% for index averages between USD 65/t and 85/t, plunging all
the way to 0.1% when index average is below USD 65/t.

 

We assume that both Metinvest and Ferrexpo are paying
USD 3/t in royalty under the current royalty regime, without any dependence on
the market prices for their products.

 

We maintain our neutral view on METINV bonds.